Co-ops: RA projected and actual

Politico Pulse has a short piece after they went through the risk adjustment flows for 2015 and they ask an interesting question:

CO-OP COLLAPSE COMING? — That’s one looming possibility, based on risk-adjustment data posted by HHS on Thursday. All but one of the 10 remaining nonprofit startups were net losers in the risk-adjustment program for 2015 and will need to pay out nearly $150 million to their competitors.

I think that is an interesting question but I also think it is the wrong question.

It is okay to pay out large net risk adjustment outflows. Centene is doing that. Molina in California is doing that. They are paying out large risk adjustment outflows because their population is comparatively healthy. Their population is healthy because these insurers are offering narrow, low cost Medicaid based networks that are really attractive to people who barely touch the medical system in any given year and expect to barely touch the medical system in the current policy year. They price their premiums and internal projections to account for the fact that their members are comparatively very healthy because their product design is aimed at scooping up the very healthy.

The better question that I think Politico should ask is if the co-ops actual risk adjustment flows were significantly better, significantly worse or materially close enough to their internal projections.

TLDR Net RA outflows are fine for well-managed co-ops, double whammy for poorly projecting co-ops.

More below the fold.

If the projections and the actual flow was close enough or if the projections had a higher outflow than what CMS actually calculated, the co-op is in fine shape (at least as far as the risk adjustment revenue issue). They calculated their risk appropriately from their product design and population attracted and their reserve position won’t be materially impacted. This is true if the co-op booked net inflows and it is true if the co-op booked large net outflows. The size of the booking is not too important, it is the gap between the projected and the actual that matters.

The big problem will be at the co-ops which projected net risk adjustment outflows and the actual came in at a much bigger net outflow than projected. At that point they are in potential trouble as their reserve position will have weakened immediately as their balance sheet will have taken a prior year hit which decreases their equity/accumulated surplus. Additionally if there is a significant discrepency between booked and actual, the auditors will probably insist on a review of the assumptions made in the booking. That means there is a very good chance that CY-16 risk adjustment projections will be revised. A new risk adjustment line item will show a higher projected risk adjustment outflow for this year unless there was a material change in plan offerings in 2016 compared to 2015 that led to a material change in the expense and health profile of the membership. If there is an adjustment, that further weakens the cash/reserve position of the co-op.

So the co-ops that are getting hit with significantly higher than projected risk adjustment outflows will be getting hit with a double whammy. An immediate adjustment to CY-15’s balance sheet and then a future adjustment to accomodate higher CY-16 risk adjustment net outflows.

At this point, I am not sure if risk adjustment is the core problem or if this is merely an indicator of greater problems at a couple of the co-ops.

BTW: the same logic also applies to private equity funded insurers — RA outflows NBD if the projections were close enough, BFD if there was a big gap.